Column : Bubble in our backyard

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While Indians have been worrying about the spillover from the global financial crisis, a homegrown crisis has been brewing gradually. Like in the US, this crisis has its origins in a bursting real estate bubble and its effects are likely to be similar.

It is a mistake to assume that the US financial crisis was caused by the kind of securitisation and financial innovation that has been repressed in India. The deadliest financial innovation at the heart of the global financial crisis is a millennia-old innovation called the mortgage loan. We have had plenty of that in India.

During the last few years, India experienced a bubble in both residential and commercial real estate fuelled by easy availability of credit. Indians have been buying expensive houses almost completely financed by banks. The cumulative loan to value ratio including “furniture loans” and other forms of financing has been close to (and has sometimes exceeded) 100%. Unlike in the past, many of these transactions have been largely free of black money and therefore there is no hidden cushion in the loan to value ratio. Moreover, our young upwardly mobile professionals have been taking on large mortgage payments (EMIs) assuming that these would be affordable on the basis of projected salaries one or two years down the line. With declining salary growth, the affordability of these mortgages is now questionable.

Commercial real estate has been equally if not more frothy. Much of recent corporate lending by the banks has been to sectors like infrastructure, SEZs and retailing that have been essentially real estate plays. The real estate bubble has also helped banks to reduce non performing assets as companies have been eager to settle old problem dues in order to monetise their real estate.

The real estate bubble in India is clearly bursting. Anecdotal evidence points to declines of 20% or more in key markets. But this understates the severity of the problem. Real estate prices are sticky and they fall only gradually. Hidden discounts are more common than public price cuts. Evidence from the stock prices of real estate companies indicates that the value of their land bank has fallen by over 50%. Even if this is exaggerated, it is clear that a 30-40% nationwide fall in real estate prices from peak to trough is very likely.